Chipotle Mexican Grill (NYSE:CMG) stock had its best day since January last Wednesday thanks to hedge fund tycoon Bill Ackman.
Shares of the burrito roller gained about 6% after Ackman's Pershing Square Capital Management Fund revealed that it had purchased nearly three million shares of Chipotle, or a 9.9% stake in the company, worth $1.2 billion.
In the SEC filing, Ackman said Chipotle has a "strong brand, differentiated offering, enormous growth opportunity, and visionary leadership." He also said the stock was an "undervalued and attractive investment." The well-known activist investor did not make his intentions clear, only saying that he wished to engage with management and the board on a range of topics, including the board composition, operations, cost structure, and other components of the business.
While it's not surprising that an activist investor has targeted Chipotle, considering the stock has lost nearly half its value following a raft of foodborne illness outbreaks last year, this situation doesn't fit the standard activist playbook, which tends to call for a management shake-up, returning capital to shareholders through buybacks or dividends, selling the company, or spinning off key segments.
It was a fast-growing company that got bodyslammed by a food safety and PR crisis. The series of outbreaks including salmonella, norovirus, and E. coli was bad, but the company's flat-footed and often tone-deaf response may have been worse.
If there's one area that Ackman should focus his efforts, it's Chipotle's marketing.
Founder and co-CEO Steve Ells isn't going anywhere, and it's unlikely that veteran execs like co-CEO Monty Moran or CFO Jack Hartung will depart either. Franchising restaurants or an outright sale would be untenable to the company as well, and management has already been aggressively repurchasing shares, while the stock is down. Refranchising restaurants has been popular with other fast food chains as a way of extracting value, but Chipotle's stores are 100% company-owned after experimenting with franchises (and disliking it).
No stranger to restaurants
Ackman has meddled in the fast food business before. He owned McDonald's for a period of time starting in 2005, long enough for the stake to double, and convinced Wendy's to spin off Tim Horton's in 2005 as well, pushing the stock to double before a recession-era collapse.
More recently, Ackman bet on Restaurant Brands International, the parent of Burger King and Tim Horton's, which has also outperformed the market since the two chains merged in 2014.
However, Ackman has also had some major failures in the broader retail world, investing in Borders before it imploded and pushing to install Ron Johnson atop J.C. Penney resulting in the worst year in recent retail history. Ackman's more recent bets on Herbalife and Valeant Pharmaceuticals have also been stinkers thus far.
What Ackman could do
While the conventional restaurant plays may not apply here, there are still some areas where Ackman could influence the company.
- Chipotle's board has been called out for a lack of diversity and independence in the past. Shaking up its members or getting some fresh blood on the board could invoke a sense of urgency in Chipotle management to rethink strategies that aren't working.
- The marketing message needs an overhaul. While Ackman is not a brand expert, and that's not generally an area that activists focus on, it's the No. 1 thing the company must recalibrate to get customers back in the door. Its Food with Integrity message no longer resonates following last year's scandal. Chipotle needs to show weary diners that it's safe to eat there and convince them to return.
- And the company needs a coherent strategy with its seed concepts. It's about to launch a third concept, a burger restaurant called Tasty Made, but it has barely grown its other two brands: ShopHouse Kitchen and Pizzeria Locale. The Tasty Made addition makes it look like the company is losing focus on the central problem of sales declines at Chipotle. That may not be the case, but management needs to better explain its position, because a handful of restaurants under a different brand is not going to move the needle.
The bottom line for investors is that sales are slowly coming back and should continue to do so. Lapping the start of the crisis in November should also help the stock psychologically as comparable sales should return to growth at that point.
Ackman may not have much sway to nudge the company in a different direction, but he's right to recognize the value in the stock. Though it's taking longer than many hoped, Chipotle should bounce back over time.